Question

“Both the four-firm concentration ratio and the HHI can be affected by a merger between two firms that are not already in the top four by size.” Is this statement true or false? Briefly explain why.

Answer 1

Lets first see what four firm concentration ratio and HHI is.

Four firm concentration ratio is the percentage of the total sales in the industry that are accounted for by the largest four firms.

Herfindahl-Hirschman Index (HHI) is approach to measuring market concentration by adding the square of the market share of each firm in the industry.

Now that we have the definitions, we can see that the statement is True. Lets see why.

Lets say the four firm concentration ratio of an industry is 60, with each of the top firm controling 15% share. Then there are 4 other firms who each control 10%, for a total of 100. Now lets say two of the bottom 4 firms merge. The new entity controls 10+10=20. So this firm is now the biggest firm. The four firm concentration ratio now is 20+15+15+15=65. So, merger of two firms which were not in the top four did affect the four firm concentration ratio.

So, we can see that if the two firms merging will have a higher combined control than any of the top 4, then it will affect the four firm concentration ratio.

Now lets look at HHI. HHI is simply the squared sum of all the market share of all firms. It has nothing to do with top 4 firms. So of course it will get affected with any merger.

Hence, both of these can get affected by a merger of firms, even if they are not in tou four.

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